An old saying goes: “Our greatest glory is not in never falling, but in rising every time we fall.” This holds for stock market trading. No one invests in the stock market to lose money. But losses are a part of trading. Those who have mastered the art of stock trading do not try to avoid losses but minimise them. This could mean selling a stock when the prices are down by 7-8% from the purchase price.
For an investor, it is always difficult to admit your mistake and sell at a loss. But realising a capital loss and selling stocks before they get out of hand is what differentiates a successful investor from the rest. One of the primary lessons in investing is to learn how to deal with losses in the stock market.
Types of losses in stock trading:
Losses in the stock market can be immediate and clear or less apparent and subtle. These can be categorised into three classes:
Capital loss – Capital loss is a loss incurred when an asset is sold at a price lesser than the amount with which it was purchased. In the stock market, this happens when you lose money from selling a stock lower than its purchase price. You may hold on to the stock when prices are falling, leading to more losses. A capital loss is where you lose actual money. It can be divided into short-term and long-term capital loss and can be set off against capital gains for tax purposes.
Opportunity loss – This is the difference between optimal price and actual price payoff. For example, if you bought a stock for Rs 10,000 which at the end of a year rises by a small margin or remains at the same level, then you may think that you have not lost the money. However, in actuality, you have lost the opportunity of making more by investing Rs 10,000 elsewhere. Opportunity loss is, therefore, a loss incurred from not picking the best alternative.
Missed profit loss – Most investors are unable to call the top or bottom of a stock. As a result, investors hold on to the shares when they are rising and are unable to anticipate its fall. This happens mostly with volatile stocks which rise significantly before falling. Some investors sit tight even after the fall, hoping that the shares would recover. However, that may not happen always. The best thing for this is to be happy with a reasonable gain.
How to deal with losses in the stock market?
The best way to deal with losses in the stock market is to cut it short. Successful traders use the lessons learned from a loss to become stronger and more disciplined. Following are some steps on how to deal with losses in the stock market:
Accept responsibility – Once you have made a loss, do not hide or run from it. Taking ownership of your losses is the first step towards taking control of your investments.
Put the loss in perspective – One loss no matter how big cannot define you. You have more roles to play than just your trade. Put your perspective in place and get back to the game.
Analyse your choices – Review the options you have made and check if you could have done something differently. Some traders wait for a better opportunity; some others reverse their trade under good market conditions. They not only make up for the losses made but also move towards gains.
Plan – Experience will teach you to make the right choices. Your losses will show you what to do and what not to. Make a detailed plan for your future endeavours before plunging again.
Be motivated – Use the loss as a motivation for learning and developing your skills. Use your weakness as a catalyst to improve in the future.
Once you have recovered emotionally and financially from the losses you made, get back to the game. Avoiding losses is not possible in trading, but smart investors take corrective action and minimise losses.